ECONOMICS: Ethanol and the national interest

In a world of rising petrol prices, mandating the addition of ethanol to Australian fuel makes increasing economic sense, argues a former deputy secretary of the Department of Trade, Colin Teese.

How long must we wait for our politicians - Coalition and Labor alike - to learn the lesson that taking an independent public service out of the policy-making equation leads to bad policy?

With their ideas rooted in ideology, party stalwarts might be good at ferreting out the wish-list of the party's special-interest support groups; what they don't do so well is identify and promote the national interest.

Even when the government, without the help of a professional public service, manages to get its policy-making right - as this writer believes the Coalition did on the refugee issue - somehow it gets messed up in the implementation.

Ideological considerations did not, of course, influence the policy on refugees, but they certainly are driving the current debate concerning the privatisation of Telstra.

National Party schizophrenia aside, all the evidence suggest that the Coalition's ideological blind-spot on privatisation is getting in the way of a sensible outcome on Telstra.

It has always been obvious that a privately-owned Telstra cannot reasonably be asked to make the uneconomic investment needed to properly service the telecommunication needs of country areas.

Moreover, the incoming boss of Telstra has been unkind enough to make this clear. He does not believe it is the company's obligation to serve the needs of country people if that means cross-subsidising the country service from its general revenue stream.

And he's right, if his only responsibility is to his shareholders. Which explains why we have in the past kept certain essential service-providers in public ownership. From a policy point of view, what is needed is an agency - however owned - which can serve the public need.

The so-called "rescue package" for the Queensland sugar industry, cobbled together in the run-up to the last federal election, is another example of a bad policy outcome driven by blind commitment to ideology, rather than a careful look at what is actually needed and why.

The result has been anger and disillusionment on the part of cane-growers and sugar-users alike - the latter because they have been misled into believing that hopelessly inefficient farmers are being needlessly propped up.

Now there seems to be a real danger that the Government is in the process of messing up on the matter of whether or not to mandate the addition of ethanol to our petrol.

Interest groups

Unfortunately, various interest groups - and, additionally, and perhaps worst of all, ideological considerations - appear to be working as an agent for confusion in all of the debate so far. A further complication is the fact that, whatever the Government decides on ethanol, can have, and possibly should have, implications for the sugar industry.

The special-interest groups are the least of the Government's worries. They comprise, obviously, those whose financial interests are served by keeping ethanol out of petrol, and those who will gain financially if ethanol is mandated. Both of these groups are traditional supporters of the Coalition; but, however hard it tries, the Government cannot avoid offending one side or the other.

On that score, the Coalition is uniquely placed to set aside all interests other than the national interest. As it happens, such a policy could also serve - as some sections of the National Party seem finally to have recognised - the broader political interests of the Coalition partners.

Certainly, the right national interest outcome might emerge more easily if the destructive ideologues were not hard at work undermining the confidence of Government ministers.

These unwelcome ideological inputs come in a number of different guises. There is, of course, the economic advice coming to the Government from inside the new-fashioned bureaucracy. And some of the media, most notably the Australian Financial Review, is firmly behind them. The AFR is, as usual, generating more than its share of the confusion. No doubt ideologically-committed staffers are following faithfully behind.

Orthodox ideology holds that the question of whether or not ethanol finds its way into our petrol tanks has nothing to do with government: it is for the market to decide. In reality, that means the oil companies and the ethanol producers. Any other interference impedes the free operation of the market.

The debate has been under way for a couple of years now and, thus far, the ideologues have been able to hold ministers to a "hands-off" policy. (Labor's compliance has made this "hands-off" policy more easily manageable politically for the Coalition).

Recently, however, and all to the good, the Prime Minister appears to have lost patience with what is being developed within the relevant ministry. Perhaps the National Party has helped change his view.

At any rate, for whatever reason, Mr Howard has apparently taken over development of a position on ethanol. The rumour is that he is of a mind to require some ethanol content in fuel.

He is, of course, on the right track. But we must question whether the PM has the right kind of advisors to help him develop an appropriate policy on ethanol. A good starting-point in the search for any new policy would be to understand what other countries have done and why.

A number of major economies now have, or have in contemplation, what amounts to a policy of mandating the addition of ethanol to fuel - either directly or indirectly.

The US Government has legislation which will require a certain quantity of renewable fuel to be added to petrol. Many states already mandate various percentages of ethanol.

The US is also concerned about its dependence on imports of fuel, especially with the Middle East in turmoil. And it sees benefits for its corn-growers (crops other than cane sugar can produce ethanol).

Further, the US is looking at developing an ethanol export industry. Ethanol, it rightly believes, will become an important new export - and the more so as oil prices continue to rise.

Japan appears to be moving towards mandating the addition of ethanol to its petrol as a risk-management policy, given its dependence on imported oil. And, it is encouraging others in a position to do so - including Australia - to begin producing ethanol. Japan's ethanol must also be imported, and it does not relish the prospect of Brazil being its only source of supply.

The European Union has a multi-pronged ethanol policy. For a whole series of reasons, the EU is in the process of cutting back on production subsidies encouraging sugar exports. Ethanol production (from sugar beet) is seen as a way of replacing lost export markets for its sugar industry. Indeed, the EU is actually admitting that it will keep the subsidies on beet production for ethanol.

But the EU is also worrying about cleaner air. It is tightening its laws on atmospheric pollution. Adding ethanol to petrol will be the cheapest way of meeting the new EU standards. Finally, like Japan, the EU is alarmed about what seems to be happening in the Middle East. For the EU, it is simply a matter of marrying virtue with common sense to channel its surplus sugar production into ethanol.

A combination of self-interest and common sense, rather than ideology, is driving all of those policies, and we should take due note of it.

But, above all, Mr Howard's Coalition should understand what Brazil has done and why. Not altogether unlike the European Union, Brazil has linked sugar and ethanol; in doing so, it too, has turned necessity into virtue.

However, it had the foresight to begin the process about 20 years ahead of the field. Two decades ago, Brazil was a very large sugar producer (it is, after all, a very large country), and a significant exporter.

At that time, it was being driven from export markets by the expanding EU sugar production and export, supported by a massive subsidy program.

Brazil's sugar industry felt the effects of that pressure in much the same way as has our industry. At the same time, Brazil was concerned about its fuel import bill and the drain that was placing on the country's foreign exchange reserves.

Lifeline to cane-growers

Brazil's development of an industry for the production of ethanol from cane-sugar certainly threw a lifeline to its cane-growers.

It provided them with the opportunity to significantly increase cane production as a feedstock for ethanol on the basis of a guaranteed domestic market. The key element in the new strategy was the mandating of a percentage of ethanol into locally consumed petrol.

The results have been spectacular, though they were criticised at the beginning: ethanol was more expensive than petrol. But the policy shift also had the effect of allowing Brazil's sugar-cane production to grow enormously, and for growers to receive a worthwhile price for cane.

All of the consequences were positive. For example, the Australian Financial Review never ceases to remind our cane-growers that Brazil is the world's most efficient sugar producer - and the largest exporter. Whether the AFR has acknowledges the role of ethanol in creating that advantage for Brazil is not clear.

Make no mistake, the Brazilian experiment required huge investment. To date, Brazil has invested about US$11 billion in ethanol; but it says that over the last 20 years its ethanol program has saved it US$ 110 billion in imported fuel costs.

It is effectively an import-replacement program. But import replacement, we should not forget, is as good as export.

If we follow Brazil's example and get our policy right, we could do as well - perhaps better - because ethanol is now more competitively priced compared with oil.

We could permanently stabilise our faltering sugar industry - no more so-called "rescue packages" - and further develop an ethanol industry, with prospects for a new export industry. Goodness knows, we need one, given the state of our current account deficit.

The question is: can we get it right? Mr Howard has taken charge of the issue, and that's good - but he cannot be expected, personally, to chart the right policy direction.

He needs the right advice. He must ignore those who insist that ethanol is not the Government's business, that ethanol is not "economic". And he should neutralise the smokescreen of excise. The fact is, ethanol should pay the excise, for the same reason that we apply it to petrol. Excise is not, and should not be, an issue.

What matters is that a number of national interests can simultaneously be served if we take up the challenge of ethanol in the right way. And that means more than just mandating a percentage of ethanol to petrol, and leaving the rest to the market.